Aena SA AENA W
March 27, 2015 - 12:01pm EST by
miser861
2015 2016
Price: 83.60 EPS 4.90 6.00
Shares Out. (in M): 150 P/E 17 14
Market Cap (in $M): 12,500 P/FCF 9.3 8.3
Net Debt (in $M): 10,700 EBIT 1,200 1,400
TEV ($): 23,200 TEV/EBIT 19.3 16.6

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  • Transportation
  • Spain
  • Travel
  • Regulated monopoly
  • Children's Investment Fund
  • Europe
  • Competitive Advantage
  • Low Competition
  • Retail
  • High Barriers to Entry, Moat
  • Pricing Power
 

Description

free cash flow. If it traded for the same EV/EBITDA multiple as its best peers (16x), the equity should be
75% higher today. Also, Aena's unregulated revenue per passenger (US$4.60) is less than half the level
of its developed market, dual till peers. If unregulated revenue per passenger only reaches US$5.25 in
2018 (5nominal growth), EBITDA could grow 30% without any passenger growth and provide 75%
additional upside for the equity. Passenger volumes grew 6.2% in February. In 2018Aena would still
have spectacular latent commercial earnings powerhigher cash conversion (higher EBITDA margin,
lower tax rate, lower interest rate), and faster passenger growth than the other airport operators, and
would likely deserve a premium valuation, if not the premier valuation. Furthermore, Spain's economy
is emerging from a depression, which no other publicly-traded airport operator can claim today, and
thus domestic passenger volumes are severely cyclically depressed  down 30% from the peak.
Additionally, Aena will be a beneficiary of lower oil prices and a lower Euro. think Aena equity could
easily double over the next two years, and possibly triple. Aena is sitting on at least four potentially
powerful coiled springs: 1) valuation, 2) commercial revenue tailwind, 3) Spanish economic recovery, 4)
real estate development.
 
I’ve included a link to the underwriters’ English version of the prospectus because I’ve heard that it’s
difficult to get, and isn’t filed anywhere. The official Spanish version is filed with the CNMV and on
Aena’s IR Web site.
https://www.dropbox.com/s/fqwuyojrwaezbtr/Aena%20E-Final%20.pdf?dl=0
 
Airports earn two revenue streams: aeronautical and commercial. Aeronautical revenues are fees
charged to airlines for using the airport facilities. Airport services are a critical public good, and airport
owners wield enormous power over airline customers, so airport aeronautical activities are
regulated. Regulations limit returns on regulated assets, or at least limit price increases on regulated
services. Aeronautical fees average around 2% of the passenger's airfare ($10 domestic, $20
international), but are an irreplaceable component of the air travel service. Airports could extract
significantly more rent out of airlines if their aeronautical returns weren't capped by regulation. An
unregulated airport would usually score perfectly in all of Porter's five forces. The threat of new entry is
low. Airports are extremely expensive to build. The replacement cost of Aena's airport network is $40-
60 billion. Even if it made economic sense to build a competing airport, in large cities it's usually
impossible to build another airport as close to city center as the legacy airport. And neighbors would be
very opposed to a new airport moving in next door. Airline buyers have little choice where their
passengers must land. Threat of substitutes for long distance travel is low until someone invents
teleportation. Competitive rivalry is low. Airports don't compete to be better. A passenger doesn't
choose his destination based on the attractiveness of the airport or the customer service.
 
Commercial revenues are comprised mostly of rent from stores, restaurants, and car rental agencies, car
parking fees, and advertising. Rents usually have minimum guarantees with upside to the minimum
based on a percentage of retail sales. Airport commercial activities are usually unregulated since it isn't
a public necessity. The commercial area of an airport can be thought of as a shopping mall adjacent to
the airport gates, with captive high income shoppers. Airport commercial activities also score well on a
 
Porter scale. Buyer power is low. Not many customers are willing to leave the airport for a
meal. Supplier power is low. Tenants earn revenues and pay rents for airport square footage
comparable to the best shopping malls in America, because traffic is very high per square foot. So
airports can be thought of as some of the best mall real estate there is, with no competitive threat from
online retailing. Vacancies are negligible in good airport retail space, usually below 1%. Tenants are
easy to replace because the space is lucrative and scarce. On the other hand, a retailer can't usually
move his store to a competing airport across the street. Substitutes exist in most retail categories, a
passenger can bring a sandwich, so pricing power isn't unlimited. Competitive rivalry is low - Miami
International doesn't compete for your dining dollar with LaGuardia.
 
In 2011 Spainairport operations were carved out of ENAIRE and put into Aena. New management was
hired and tasked with improving profitability in preparation for the IPO. Aena was partially privatized by
the Spanish government on February 10th. The government remains 51% owner. 150 million shares
are outstanding. The government retained 76.5 million shares. 31.5 million shares were sold at €58 to
"cornerstone investors" including 10 million to The Children's Investment Fund. TCI also bought 1.6
million more shares on the open market up to €76.38, and 6.6 million options. Being the largest private
shareholder, Chris Hohn got a board seat. 3.8 million shares were sold to Spanish retail investors at €58
(€52.20 to Aena employees). The remaining shares were sold to Spanish and foreign institutions.
 
Aena owns 46 airports, which make up 99.9% of the commercial air traffic in Spain. Unlike most other
publicly-traded airport operators, Aena owns its airports rather than just holding an operating
concession which expires. Aena also holds a national monopoly. Most other publicly traded airport
operators hold a regional monopoly.
 
There are likely strong advantages to owning all the airports in a country. For starters, you’re more
protected from new entrants than the regional monopolies. There is also no risk that airlines can divert
traffic as a negotiating strategy. Aena’s traffic is also significantly more diversified among carriers than
its peers.
 
There are probably huge cost efficiencies from having all the airports under one operating company. At
a high level this is confirmed by Aena’s industry low cash operating costs per passenger, which approach
the levels of its developing world peers, even though it was government agency until two months ago.
Aena owns three times as many airports as the next largest airport operator.
 
US$ Cash Cost per Passenger:
Aena            6.69
Sydney         4.51
Beijing          5.89
Auckland       5.96
Thailand        6.18
GAP              6.61
Malaysia        8.18
ASUR            9.57
OMA             9.64
Copenhagen 10.10
Zurich          17.87
Vienna         19.29
Paris            20.74
Frankfurt     31.42
Mean          12.00
Median        9.57
 
Regulation
Probably the most important place to start reading is this relatively good explanation of the regulatory
regime published by Aena’s regulator:
http://www.cnmc.es/Portals/0/Ficheros/Transporte_Postales/resoluciones_postal/2014/1409_Septiem
bre/140911_Resoluci%C3%B3n%20Modificacion%20tarifaria_ingl%C3%A9s.pdf
 
At a high level, Aena’s aeronautical revenue is capped at operating expenses plus depreciation plus cost
of capital. Historically, commercial EBITDA acted like a contra-expense in this calculation. In 2014 the
deregulation of commercial activities was begun, 80% of the commercial EBITDA offset regulated
expenses, and in 2015 60% will, and so on until in 2018 no commercial EBITDA is used to offset
regulated expenses. In this way, the ability to earn more revenue is freed up.
 
Separately, Aena signed an agreement with the airline associations which caps its 2015-2025 regulated
revenue per passenger at 2014 levels. I believe it was a show of good faith to assuage airlines’ concerns
about the privatization procesand the perception that there will be price gouging. And realistically,
this arrangement isn’t much different than the 1.0-1.5% tariff increases most airports get, with lower
traffic growth. The airline agreement still allows Aena to grow regulated revenues in aggregate if
passengers grow (though still subject to the regulatory maximum). I also think that this price cap
stimulates passenger growth in two ways going forward: 1) Aena will develop an even larger relative
price advantage over the other European airports over time as their prices decline in real terms, 2) it
creates stability for airlines who are planning new routes to Spain.
 
If Aena over- or under-earns versus the regulatory maximum, they are expected to amortize the surplus
or deficit back to neutral. As you’ll see in the CNMC document, Aena is expected to end 2014 with an
amortizable deficit of €230 million, and 2015 with a deficit of €291 million, so they are not over-earning
at present, and in fact have a cumulative deficit of 10-12% of annual regulated revenue which can be
amortized back into revenue.
 
In 2015 and 2016 the cost of capital will be down versus 2014. Also the regulated asset base (RAB) will
decline due to depreciation exceeding capex by at least €400 million per year. I expect the RAB to
decline by up to 4.5% per year, so organic regulated revenue probably won’t grow much if any, except
 
 
that deregulating commercial revenue will create a vacuum that may be filled with additional regulated
revenue, but obviously due to the contractual cap on per passenger fees, that growth would have to
come from passenger growth and/or more commercial revenue. Passengers have grown about 5% YOY
the last three months, and I think that’s a decent recovery growth estimate. Another reason regulated
revenue could grow is if Spanish government bond yields rise, or if Aena de-levers. Aena’s average debt
maturity is 13 years and is priced on LIBOR.
 
I think maximum regulated revenue can be modeled pretty reliably using the regulatory formula. Once
you have the formula, there are two market-based inputs: Spanish bond yields and Spanish CPI. This is
what I’ve done rather than just targeting revenue per passenger multiplied by passengers. With 5%
passenger growth, regulated revenue remains at the present level of about €11.40/passenger.
 
Why iAENA under-earning?
Probably a combination of a loosely economically motivated owner, and a nonsensical regulatory
regime. Before 2014, all revenues were counted in determining Aena's regulated returns. This is known
as a single till system. In other words, EBITDA from duty free shops was added to the numerator used to
calculate the return on the regulated assets denominator. Starting in 2014, Aena's regulator began the
process of de-regulating the non-aeronautical activities toward a dual till system. In 2013, 100% of non-
aeronautical revenues were counted toward the regulated return. In 2014, 80% of non-aeronautical
revenues counted toward the regulated return. This process will continue in 20% increments until 0% of
non-aeronautical revenues will count toward the regulated return in 2018. This frees up the ability to
earn about 20% more commercial revenue each year through 2018, then commercial revenues can be
as high as the market will bear. These revenues flow through at extremely high incremental margins,
since the revenue is essentially just rent with little associated operating expenses on Aena’s end.
Overall EBITDA margins on commercial revenues today are 85%, and go-forward incremental margins
are likely even higher. Historically, if Aena wanted to earn more commercial revenue, they had to offset
that growth with lower aeronautical fees, so there was no incentive to develop the commercial
business.
 
I don't think Aena is structurally disadvantaged in terms of passenger incomes. Aena's passengers are
almost all higher-income EU and Spanish citizens.
 
Weighted average GDP per capita, using passenger mix, and 2014 nominal GDP (not PPP) at 23/3/15
exchange rates:
 
Aena    US$28,200
Paris    US$28,100
Vienna US$28,900
Zurich  US$28,200
 
Commercial revenue per passenger, in USD:
Aena             4.64
Developed peers:
Vienna          6.70
Frankfurt       8.15
Copenhagen  10.47
Auckland      11.68
Sydney        12.00
Paris            14.30
Zurich         15.10
Emerging peers:
ASUR          5.65
Thailand      5.30
GAP            3.65
Malaysia     2.00
 
Aena's commercial revenue per passenger has more in common with its emerging market peers than
with their European peers. GAP in particular has a high share of local passengers, such as in their largest
airport in Guadalajara, with potentially much lower average incomes than Aena's passengers. For this
reason I'm comfortable that commercial revenue per passenger is both unnaturally low and is highly
unlikely to go much lower. It’s important to note that Vienna operates under a single till regulatory
regime, so Vienna is not a good comp.
 
Aeroports de Paris was privatized in 2006. Over the ensuing eight years commercial revenue per
passenger grew at an 8% CAGR from a starting base twice that of Aena’s, and grew every year through
an intense, prolonged recession during the majority of this timeframe. ADP is 51% owned by the French
government, and the CEO receives no bonus and no stock options.
 
Aeroports de Paris commercial revenues per passenger:
 
 
 
Aena will tell you that they’re different. Their passengers are poorer, they claim. While their domestic
passengers probably do have lower average incomes, in aggregate Aena has no basis for this claim.
They have a higher share of LCC traffic, which statistically has unclear effects on commercial revenue per
passenger, since LCC passengers aren’t served meals in-flight. They have a lower share of business
travelers, but business travelers actually have a lower average spend than leisure travelers. It’s not
surprising to me that Aena doesn’t want to advertise the revenue opportunities they have. As Peter
Thiel says, monopolists will always lie about the strength of their business to avoid attracting regulatory
scrutiny and competition, and competitively weak companies will always lie about the weakness of their
business to attract capital.
 
Where specifically is Aena under-earning?
 
Parking
One of the biggest opportunities in commercial revenue appears to be in parking.
On parking revenue per domestic passenger, Aena lags very far behind other airport operators:
 
(All numbers in USD)
Aena             1.89
Vienna          3.75
Sydney         4.33
Auckland       4.72
Zurich           9.13
Frankfurt       12.21
Paris             12.47
Copenhagen  23.76
 
I think this metric might potentially understate the true size of the gap in parking revenue per local
passenger. Because Aena owns all the airports in Spain, virtually every domestic passenger is local to an
Aena airport and is likely a potential airport parking customer. Since the other airports only hold
regional monopolies, not every domestic passenger is local and so not every domestic passenger is a
potential airport parking customer at those airports.
 
On revenue per parking space per year, Aena also lags substantially.
(All numbers in USD)
Aena              1,014
Vienna           1,952
ADP               3,987
Zurich            4,017
Auckland        4,343
Copenhagen   5,187
Frankfurt       5,633
Sydney         6,548
 
Garage parking price for 24 hours, in USD:
Madrid           22.75
Barcelona       22.75
Tijuana          14.00
Auckland        35.00
Paris-CDG      42.60
Copenhagen   44.00
Vienna           43.50
Zurich           48.00
Frankfurt       60.00
Sydney          71.00
 
Part of the parking revenue per passenger gap is explained by passenger income. But I think Aena’s
parking is underpriced relative to passenger income. Below is a scatter plot of GDP per capita in USD at
current exchange rates against the multiple of GDP per capita to parking prices. The red dot is Aena
today, with my 2018 base case in purple and 2018 best case in green.
 
 
 
 
If other airports’ experiences are any guide, at Aena’s passenger income level, they could probably
charge closer to US$28 for a garage space today versus US$23.
 
There are also some signs of inefficient price discrimination. Some terminals don’t price discriminate
between garage and surface lot parking. And the corporate terminal lots charge the same as regular
terminal lots.
 
Parking usage is also probably driven by passenger income, among other factors. So I think as the
Spanish economy recovers, passenger proclivity to use parking may rise. Aena’s parking utilization is the
same as the Mexican airports. Aena might be able to do things to stimulate demand too, like the recent
addition of online booking, which I believe is a way to target the more price conscious segment and
match the capabilities of their off-airport competition. Aena has also been more actively marketing
their parking. I believe utilization improved by 7% in 2014, just related to the launch of online booking.
 
 
 
 
The upshot of all this is, if Aena can close the price and usage gaps over 4-5 years, parking revenue per
domestic passenger could grow at a 10-20% annual rate. In 2018 Aena could be earning US$3-4 per
domestic passenger versus US$1.90 today.
 
Retail
Retail (duty free, other shops, and food & beverage) revenue per passenger, in USD:
Aena             2.12
Vienna          2.04
Frankfurt       3.64
Paris             3.74
Copenhagen  4.05
Zurich           4.36
Sydney          5.23
Auckland        6.47
 
How were retail revenues kept unnaturally low? One likely way is below-market rent. In October 2012
Aena signed a new agreement with their duty free shop operator, World Duty Free Group, which
increased Aena's duty free revenue share from 26.9% to 37.4%, and provided for higher guaranteed
minimum annual rent. Aena left more than 30% of their duty free revenue on the table  this wouldn’t
be likely in a dual till, profit-motivated company. I was told by the company that the reason Aena
underpriced this operator’s contract was because WDF is a preferred, local operator, but WDF is an
Italian company which is majority owned by billionaires. The company also told me that the duty free
contract renewal was an aggressive process that isn’t likely to be repeated with the other operators, but
the duty free contract renewal was an open tender process in which seven operators participated, just
like every other duty free tender in every other airport in the world. And the revenue share is in line
with other recent duty free tenders. Aena has also been renegotiating the revenue shares on other
retail and food & beverage outlets.
 
The increase in guaranteed minimum rent on their duty free shops of €60 million in 2015 versus 2014
rent is enough in itself to contractually guarantee 7.4total commercial revenue growth for 2015
without doing anything else. The increased minimum guaranteed rent will cause duty free revenue to
grow at least 34% in 2015 and at least 15% annualized over the next four years (9% annualized 2016-
2018 even after the big ramp in 2015).
 
Because WDF is a public company, and they are the only duty free shop operator in Spain, it’s easy to
track the underlying performance of the duty free shops. WDF has spoken extensively about the Aena
contracts publicly because it caused a hit to their EBITDA margins in 2013 and 2014. I believe, based on
WDF’s public statements, that they were earning margins on the Aena business of about 22% in 2012,
nearly twice the 12% company-wide average. That’s money that was being charitably donated by the
Spanish government to Italian billionaires and other WDF shareholders.
 
WDF has said they expect the Spanish same-store revenues to grow at 7.5% per year through 2017 (3%
passenger growth and 4.5% average spend). But there’s two interesting things to note here:
1) they also project their global same-store sales ex-Spain to grow 7.8% annualized in that same time
period, even though Spanish passenger volume is substantially more depressed than the rest of the
world. They expect Spanish passengers to grow 3% but project global passengers ex-Spain to grow
3.4%. WDF’s Spanish duty free same-store sales grew 8.8% in 2014 while Spanish nominal GDP grew
just .9%, the Euro averaged 20% above today’s level, and the Brent oil price averaged 80% higher than
today’s levelAena’s February traffic growth was 6.2%, and global traffic grew 6% in 2014.
2) WDF was given the right to expand Spanish duty free square meters by 33% from 33,000 in 2012 to
45,000. Square meters grew 18% in 2013, and I think square meters grew 5% in 2014 (subtracting same-
store sales growth of 9% from total sales growth of 14%). This leaves WDF room to grow square meters
by an additional 10% in 2015, which appears to be happening, based on their statements that in the first
two months of 2015 total Spanish sales are up 22.5% and same-store sales are up 6.8%. However, as
you can see in the chart below, when WDF modeled 2017 Spanish sales, they didn’t include any growth
in square meters, and I believe the current 2015 run-rate Spanish sales are higher than their 2017
guidance.
 
 
 
Source: World Duty Free Group
 
I think there are at least two incentives for WDF to minimize the opportunity for recovery in Spain. 1)
WDF has said that they would like to renegotiate the terms of the Aena contracts on the basis that
Aena’s 2013 traffic forecasts were too optimistic. Aena modeled 5.5% passenger growth for 2013 prior
to the October 2012 duty free auction process. Actual 2013 traffic declined 12% in Madrid, leaving an
eight million passenger deficit versus forecast just in Madrid. 2) the WDF CEO lost his job over the Aena
contract, and the new CEO probably wants to make sure expectations are low.
 
If WDF’s Spanish sales grow 20% in 2015 and 8% thereafter, I expect that their margins in Spain will
recover to 16% in 2018, well above company average, and rent could be above the guaranteed
minimum. The WDF contract runs through the end of October 2020.
 
Duty free will be over 50% of retail revenue in 2015. Food and beverage will be 27% of retail revenue in
2015. I just grow food and beverage revenues by 3% per passenger because Aena actually performs well
in that category, but Aena has noted some initiatives to improve here. The other 20%, convenience
stores and such, I have less insight into but I have a hard time believing that the duty free rents were the
only ones underpriced. I grow these other retail revenues at 5% per passenger.
 
The upshot is, I believe with high conviction that duty free sales per passenger will grow to US$1.50 in
2018 from US$1.03 in 2014, a 9.5% annual rate. The minimum guaranteed duty free rent will be
US$1.46 per passenger in 2018, so if the actual varies from my estimate, it wont be more than
US$.04/passenger lower.
 
 
Advertising
I think advertising revenue is probably a pretty straight forward inefficiency to correct. Aena’s
passengers are essentially the same people as most of the other European airport passengers. I also
believe that tourist destination ad space is worth more than other airport ad space, because of the large
potential spend involved, immediacy of decisions, and very targeted audience. I think Aena could easily
earn .30-.40 per passenger one day, possibly more because of its high mix of tourist traffic. Note that
Aena is earning 65% less per passenger than single till peer Vienna.
 
Advertising revenue per passenger (USD):
Aena    .141
GAP     .27
ASUR   .29
Paris    .338
OMA     .397
Vienna  .408
Zurich   .671
 
Capex
Aena's has committed to cutting capex going forward. The company estimates in its prospectus that its
airports have the capacity to handle 335 million passengers comfortably within the confines of the
current operating hours, current quality of service levels and current regulatory and environmental
restrictions. This compares to 2014 traffic of 196 million passengers, giving them room to grow
passengers 67% before needing to add aggregate new capacity. Management believes Aena has enough
capacity to accommodate growth through 2025 and beyond.In many airports Aena is operating at 50%
of capacity.Like the rest of Spain, the airports were overbuilt in the credit boom.
 
 
Source: Aena
 
2014 utilization versus theoretical passenger capacity, based on company-supplied public data:
Aena            59%
Sydney         65%
Vienna          75%
Zurich           79%
Copenhagen  85%
Paris             87%
Frankfurt       88%
 
For the next 10 years, Aena is limited by regulation to spending no more than €450 million per year in
capex. Overspending on capex needlessly costs the airlines because it increases the RAB. So whatever
you think true maintenance capex is, €450 million is the worst case by law.
 
Here's how Aena breaks out their capex spend over the last three years:
                               2014  2013  2012
Capacity Expansion   72      149     381
Expropriation            78      91      76
Other                       21      59      125
Total Growth Capex   171    299    582
Security                    33     79      125
Environment             12     18       22
Service Maintenance  84     72       66
Total Maintenance     129   169      213
 
Security and Environment are maintenance costs since security technology will always need to be
improved and not just maintained. Environmental capex mainly relates to sound insulation costs for
nearby homes. Expropriation is money that's spent to buy the land necessary to add runways and
terminals. I'm including Other in growth because it includes mostly capex to expand and improve
commercial square footage and it generates a good incremental return.
 
The average annual maintenance capex over the last three years has been 170 million. I'm using €200
million going forward.
 
Sydney management says that their maintenance capex is A$15 million per year because of their
advantageous utilization position. If Aena spent at the same percentage of gross PP&E, their
maintenance capex would be €88 million. Sydney’s estimate seems aggressive to me, but management
is confident enough in it to pay out 100% of EBITDA - Interest - Taxes - Maintenance Capex. This is one
reason I believe Sydney gets the premier valuation in the sector, and I believe Aena could be similarly
situated if they demonstrated Aena’s earnings power with an aggressive dividend payout policy.
Sydney’s equity trades for 25x this measure of no-growth FCF, and is growing passengers and
commercial revenue per passenger more slowly than Aena is growing. Aena is likely the best-situated
airport in the developed world in terms of capital needs per incremental passenger for the next 10+
years.
 
What are the political risks?
Podemos, a radical left party is polling well  probably in a dead heat with the governing conservative
party  for the general election on 20 December 2015, in which almost all seats in the legislature are up
for re-election. Privatizations are unpopular with left-leaning politicians. So it's important to spend a lot
of time thinking about this risk, though I’m a very unqualified Spanish political analyst.
 
I don't expect that raising commercial revenues will be politically unpopular. For one, airport
passengers are mostly higher income. For two, these are discretionary purchases for these higher
income passengersAena has agreed to freeze non-discretionary fees for 10 years. For three, the
revenue that we're talking about will actually be coming from concession operators who were
previously being subsidized. I don't think that Podemos cares about either constituency. They perhaps
do care about the tax revenue and dividends that the government will get from Aena. I also think that
the Spanish and European courts may provide a reasonably reliable source of property rights protection.
Spain and the EU are real governments with legitimate court systems, and they aren’t Venezuela.
 
One Podemos legislator mentioned that he wanted to re-nationalize Aena, though he subsequently de-
escalated his rhetoric to just say that Spain should never sell more than 49%. Other than that, the news
about Aena has been a trickle at most since after the IPO.
 
I think the biggest risk is if the legislature reverses the switch to a dual till system, but I see virtually no
incentive to do so. Podemos won’t win a majority in the legislature (they’re polling at 22.5%), so they
wonhave free rein to create a socialist utopia. An aggressive regulator could play with some of the
variables used to calculate Aena’s regulated income, though I think these kinds of changes would have a
relatively small effect.
 
I would also note that the French government owns 51% of Aeroports de Paris, and ADP has the highest
commercial revenue per passenger of all the publicly traded comps and are guiding to phenomenal
growth of 18% in 2015 to €19/passenger. That has caused no controversy.
 
In some ways a Podemos victory could be positive for Aena. If Spanish yields rise as Greek yields did
after Syriza’s victory, it will increase Aena’s regulatory cost of capital without increasing its actual cost of
capital. Podemos has spoken openly about wanting to restructure the national debt. Also if Podemos
engages in fiscal stimulus, it will be positive for Spanish GDP.
 
Land Holdings
Aena owns 4,940 acres (2,000 hectares) of land adjacent to its airports that it describes in its prospectus
as “largely underdeveloped. 80% of this land is in Madrid and Barcelona, according to former
management. Former management believes there is a lot of pent up demand for airport hotels in
Madrid and Barcelona.
 
Auckland International owns 3,707 acres adjacent to its airport that it values at US$2.65 billion, or
US$536,000 per acre at 30/9/14. At the same value per acre, Aena’s land could be worth €2.3 billion.
 
Airports de Paris owns 3,200 acres (1,310 hectares) of excess land that they have been aggressively
leasing out. Their appraisers have valued it at €2.1 billion at 12/31/14, €650,000 per acre. At the same
valuation per acre, Aena’s land could be worth €3.2 billion. ADP has leased out about 70% of their land,
probably 90% subject only to land leases, and is earning €120,000 per acre.
 
Source: Aeroports de Paris 2013 annual report
 
 
Here’s a scenario in which Aena forms a SOCIMI (Spanish REIT) and leases out their 4,940 acres at the
same rate per acre as ADP:
 
European REITs get EBITDA multiples of 15-20x, and I think Aena’SOCIMI would be worth a high
EBITDA multiple since land leases require less capex. Even if the SOCIMI spin-off doesn’t work out, the
rental EBITDA would be worth €3 billion after paying a 25% tax rate.
 
Maybe land has little value in Spain right now since there is probably very little marginal development,
but France isn’t doing so hot either. Maybe there aren’t enough businesses willing to absorb 4,900
acres next to the airports. But it’s a lot of land that isn’t totally in the boonies, and even at half the
valuation per acre of ADP, it could be worth €1.6 billion. At any rate, I’m not including this value in my
target price.
 
Leverage
Aena ended 2014 with 5.7x debt/EBITDA. Their long-term leverage target is 5.0-5.5x. An interesting
footnote is that Aena allocates €12.8 billion of assets to Aeronautical and says it has a 72% debt/capital
ratio. If this is the case then €9.2 billion of the debt is allocated to the Aeronautical segment, leaving
about €900 million in the Commercial segments. This is also confirmed by Commercial segment interest
expense of 15.9 million in 2014, implying 839 million of average debt outstanding in 2014. Here is an
estimate of the relative leverage ratio of the segments on 2015 EBITDA:
 
                    Debt    EBITDA   Debt/EBITDA
Aeronautical  9,200  1,300      7.1x
Commercial   900     760        1.2x
 
The reason I think this is interesting is because it puts Aena in a position to delever the Aeronautical
segment and raise its regulated cost of capital over time by building equity, while increasing Commercial
leverage and maintaining overall leverage flat. I believe Aena can dividend about 400% of its
Commercial net income per year, maintain leverage at 5.25x, and still increase its WACC and thus its
maximum regulated revenues.
 
Valuation
EBITDA multiples correlate most strongly to EBITDA margins. Higher
EBITDA margins result in a higher percent of EBITDA converting to free cash flow, and so the same FCF
multiple will result in a higher EBITDA multiple all else equal. 
 
Comps, all numbers in million USD:
 
                     EV         2015 EBITDA   Multiple  Margin   EBITDA Growth
Sydney          14,400   780                18.5x      82%      5.5%
Auckland        5,600    290                19.3x      76%      7.4%
Thailand        12,700   770                16.5x      58%      16%
ASUR            4,100     271                15.1x      55%      12.3%
OMA             2,000    136                 14.7x      49%      15%
GAP              3,700    274                 13.5x      63%      11.1%
Copenhagen  4,550    333                13.7x       56%      5.0%
Paris            15,200   1,292              11.8x      40%      6.8%
Frankfurt      9,750    922                10.6x       33%      4.6%
Zurich          5,500    565                 9.7x        55%      3.1%
Vienna          2,500   287                 8.7x        40%      5.1%
 
 
 

 
Following the regression line through EBITDA margin versus EBITDA multiple tells me that at 64%,
Aena’s 2017 EBITDA multiple should be about 16x.
 
Model
In this model I’ve assumed Spanish yields increase linearly 10 bps annually to 3.0% in 2025, from 2.0%
currently. The historical average is closer to 5%.
 
                                  2018   2017    2016    2015    2014
Passengers                  239.2  227.8   217.0   206.6   195.9
YOY                            5%      5%      5%      5%       5.5%
 
Aeronautical Revenue   2,775   2,556  2,521   2,357   2,242
Per Passenger             11.60   11.22   11.62  11.41   11.44
Aeronautical EBITDA    1,528   1,403   1,385  1,289   1,221
 
Commercial Revenue   1,256   1,136   1,027   929     837
Per Passenger             5.25     4.99    4.74     4.50    4.27
Commercial EBITDA    1,032    924     826      738     654
 
Total EBITDA              2,560    2,326  2,211   2,027  1,875
Deprec. & Amort.        815       815     815     815      815
Interest Expense        100       133     163     191      200
Pre-Tax Income         1,645     1,378  1,233  1,021   860
Taxes                       411        345     308     286     258
Net Income               1,234     1,033  925     735     602
Add: D&A                 815        815     815     815     815
Less: Maint. Capex    200        200     200     200     200
Maintenance FCF      1,849      1,648  1,540  1,350  1,217
 
Debt                        4,311      6,169 7,827   9,375 10,733
 
2017 EBITDA                2,326
Multiple                        16x
EV                                37,200
31/12/16 Debt              7,827
31/12/16 Equity Value   29,400
Shares Outstanding       150
31/12/16 Share Price    196
 
Alternatively, 16x maintenance FCF per share of €11 in 2017 gets me €176 per share.
 
This model makes no assumptions about dividend reinvestment, and simply assumes that all free cash
flow goes to debt paydown at a 1.5after-tax return.
 
Dividends
Management has stated their intention to pay out 50% of net income in dividends. Net income is about
50% of distributable free cash flow in 2015 and two-thirds of distributable free cash flow in 2018. If
Aena doesn’t want to de-lever, then 50% of net income is plainly an inadequate dividend. After months
of research, my embarrassing conclusion is that infrastructure asset EBITDA multiples are most closely
correlated with the dividend payout ratio. Investors will pay more for cash flow that they can see and
feel. Unless the market is forced to look at distributable free cash flow, then the market probably won’t
look at distributable free cash flow, and the stock will be valued haphazardly. Sydney and Auckland
have forced the market to look at distributable free cash flow, and Sydney and Auckland get the highest
valuations of any airport assets in the world. Lowest common denominator investment theses aren’t
my favorite, but in this situation I don’t think there are any other real alternatives for reinvestment.
Capex is restricted by law. Acquisitions will be small and infrequent given management’s admirable 10-
12% IRR hurdle. Buying 51% of Luton’s equity, as an example, only cost Aena €65 million and had an
enterprise value of €500 million. Luton was a fabulous investment, but it probably only has an equity
value per Aena share of €1.50 today and probably consumes disproportionate management energy.
And airports don’t come up for sale often, unlike some other industries. So for the first time in my
career, I’ve found myself hoping for dividends, and I’m not a yield investor and have no need for income.
I would probably just reinvest my dividends into Aena stock.
 
I also think that it’s completely within the government’s best interests to maximize their Aena dividends
for fiscal stimulus programs to help build momentum behind the Spanish economic recovery, or to
provide some relief from crippling budget austerity. If Aena paid out 150% of distributable FCF in
dividends, which I think is possible within the confines of their leverage targets, the government could
earn €1.5 billion in dividends from their Aena stake in 2018 (€4.5 billion cumulatively 2015 through
2018). €4.5 billion is 17of Spain’s 2015-2017 projected primary deficit. The dividend in that scenario
would be €20/share in 2018, a 24% yield on today’s stock price. Continental European comps trade for
an average 2.1% dividend yield. The Australian and New Zealand comps, where interest rates are 1-2%
higher, trade for 4.5% and 3.2% yields. Aena trades for a 3% yield on the stated 50% of net income
dividend payout ratio policy, but has the capacity to pay an 11% dividend yield with just a 100%
distributable free cash flow payout ratio. Put simply, a single effortless decision could cause the stock to
double or triple tomorrow.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

-Commercial revenue performance

-Dividends

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    Description

    free cash flow. If it traded for the same EV/EBITDA multiple as its best peers (16x), the equity should be
    75% higher today. Also, Aena's unregulated revenue per passenger (US$4.60) is less than half the level
    of its developed market, dual till peers. If unregulated revenue per passenger only reaches US$5.25 in
    2018 (5nominal growth), EBITDA could grow 30% without any passenger growth and provide 75%
    additional upside for the equity. Passenger volumes grew 6.2% in February. In 2018Aena would still
    have spectacular latent commercial earnings powerhigher cash conversion (higher EBITDA margin,
    lower tax rate, lower interest rate), and faster passenger growth than the other airport operators, and
    would likely deserve a premium valuation, if not the premier valuation. Furthermore, Spain's economy
    is emerging from a depression, which no other publicly-traded airport operator can claim today, and
    thus domestic passenger volumes are severely cyclically depressed  down 30% from the peak.
    Additionally, Aena will be a beneficiary of lower oil prices and a lower Euro. think Aena equity could
    easily double over the next two years, and possibly triple. Aena is sitting on at least four potentially
    powerful coiled springs: 1) valuation, 2) commercial revenue tailwind, 3) Spanish economic recovery, 4)
    real estate development.
     
    I’ve included a link to the underwriters’ English version of the prospectus because I’ve heard that it’s
    difficult to get, and isn’t filed anywhere. The official Spanish version is filed with the CNMV and on
    Aena’s IR Web site.
    https://www.dropbox.com/s/fqwuyojrwaezbtr/Aena%20E-Final%20.pdf?dl=0
     
    Airports earn two revenue streams: aeronautical and commercial. Aeronautical revenues are fees
    charged to airlines for using the airport facilities. Airport services are a critical public good, and airport
    owners wield enormous power over airline customers, so airport aeronautical activities are
    regulated. Regulations limit returns on regulated assets, or at least limit price increases on regulated
    services. Aeronautical fees average around 2% of the passenger's airfare ($10 domestic, $20
    international), but are an irreplaceable component of the air travel service. Airports could extract
    significantly more rent out of airlines if their aeronautical returns weren't capped by regulation. An
    unregulated airport would usually score perfectly in all of Porter's five forces. The threat of new entry is
    low. Airports are extremely expensive to build. The replacement cost of Aena's airport network is $40-
    60 billion. Even if it made economic sense to build a competing airport, in large cities it's usually
    impossible to build another airport as close to city center as the legacy airport. And neighbors would be
    very opposed to a new airport moving in next door. Airline buyers have little choice where their
    passengers must land. Threat of substitutes for long distance travel is low until someone invents
    teleportation. Competitive rivalry is low. Airports don't compete to be better. A passenger doesn't
    choose his destination based on the attractiveness of the airport or the customer service.
     
    Commercial revenues are comprised mostly of rent from stores, restaurants, and car rental agencies, car
    parking fees, and advertising. Rents usually have minimum guarantees with upside to the minimum
    based on a percentage of retail sales. Airport commercial activities are usually unregulated since it isn't
    a public necessity. The commercial area of an airport can be thought of as a shopping mall adjacent to
    the airport gates, with captive high income shoppers. Airport commercial activities also score well on a
     
    Porter scale. Buyer power is low. Not many customers are willing to leave the airport for a
    meal. Supplier power is low. Tenants earn revenues and pay rents for airport square footage
    comparable to the best shopping malls in America, because traffic is very high per square foot. So
    airports can be thought of as some of the best mall real estate there is, with no competitive threat from
    online retailing. Vacancies are negligible in good airport retail space, usually below 1%. Tenants are
    easy to replace because the space is lucrative and scarce. On the other hand, a retailer can't usually
    move his store to a competing airport across the street. Substitutes exist in most retail categories, a
    passenger can bring a sandwich, so pricing power isn't unlimited. Competitive rivalry is low - Miami
    International doesn't compete for your dining dollar with LaGuardia.
     
    In 2011 Spainairport operations were carved out of ENAIRE and put into Aena. New management was
    hired and tasked with improving profitability in preparation for the IPO. Aena was partially privatized by
    the Spanish government on February 10th. The government remains 51% owner. 150 million shares
    are outstanding. The government retained 76.5 million shares. 31.5 million shares were sold at €58 to
    "cornerstone investors" including 10 million to The Children's Investment Fund. TCI also bought 1.6
    million more shares on the open market up to €76.38, and 6.6 million options. Being the largest private
    shareholder, Chris Hohn got a board seat. 3.8 million shares were sold to Spanish retail investors at €58
    (€52.20 to Aena employees). The remaining shares were sold to Spanish and foreign institutions.
     
    Aena owns 46 airports, which make up 99.9% of the commercial air traffic in Spain. Unlike most other
    publicly-traded airport operators, Aena owns its airports rather than just holding an operating
    concession which expires. Aena also holds a national monopoly. Most other publicly traded airport
    operators hold a regional monopoly.
     
    There are likely strong advantages to owning all the airports in a country. For starters, you’re more
    protected from new entrants than the regional monopolies. There is also no risk that airlines can divert
    traffic as a negotiating strategy. Aena’s traffic is also significantly more diversified among carriers than
    its peers.
     
    There are probably huge cost efficiencies from having all the airports under one operating company. At
    a high level this is confirmed by Aena’s industry low cash operating costs per passenger, which approach
    the levels of its developing world peers, even though it was government agency until two months ago.
    Aena owns three times as many airports as the next largest airport operator.
     
    US$ Cash Cost per Passenger:
    Aena            6.69
    Sydney         4.51
    Beijing          5.89
    Auckland       5.96
    Thailand        6.18
    GAP              6.61
    Malaysia        8.18
    ASUR            9.57
    OMA             9.64
    Copenhagen 10.10
    Zurich          17.87
    Vienna         19.29
    Paris            20.74
    Frankfurt     31.42
    Mean          12.00
    Median        9.57
     
    Regulation
    Probably the most important place to start reading is this relatively good explanation of the regulatory
    regime published by Aena’s regulator:
    http://www.cnmc.es/Portals/0/Ficheros/Transporte_Postales/resoluciones_postal/2014/1409_Septiem
    bre/140911_Resoluci%C3%B3n%20Modificacion%20tarifaria_ingl%C3%A9s.pdf
     
    At a high level, Aena’s aeronautical revenue is capped at operating expenses plus depreciation plus cost
    of capital. Historically, commercial EBITDA acted like a contra-expense in this calculation. In 2014 the
    deregulation of commercial activities was begun, 80% of the commercial EBITDA offset regulated
    expenses, and in 2015 60% will, and so on until in 2018 no commercial EBITDA is used to offset
    regulated expenses. In this way, the ability to earn more revenue is freed up.
     
    Separately, Aena signed an agreement with the airline associations which caps its 2015-2025 regulated
    revenue per passenger at 2014 levels. I believe it was a show of good faith to assuage airlines’ concerns
    about the privatization procesand the perception that there will be price gouging. And realistically,
    this arrangement isn’t much different than the 1.0-1.5% tariff increases most airports get, with lower
    traffic growth. The airline agreement still allows Aena to grow regulated revenues in aggregate if
    passengers grow (though still subject to the regulatory maximum). I also think that this price cap
    stimulates passenger growth in two ways going forward: 1) Aena will develop an even larger relative
    price advantage over the other European airports over time as their prices decline in real terms, 2) it
    creates stability for airlines who are planning new routes to Spain.
     
    If Aena over- or under-earns versus the regulatory maximum, they are expected to amortize the surplus
    or deficit back to neutral. As you’ll see in the CNMC document, Aena is expected to end 2014 with an
    amortizable deficit of €230 million, and 2015 with a deficit of €291 million, so they are not over-earning
    at present, and in fact have a cumulative deficit of 10-12% of annual regulated revenue which can be
    amortized back into revenue.
     
    In 2015 and 2016 the cost of capital will be down versus 2014. Also the regulated asset base (RAB) will
    decline due to depreciation exceeding capex by at least €400 million per year. I expect the RAB to
    decline by up to 4.5% per year, so organic regulated revenue probably won’t grow much if any, except
     
     
    that deregulating commercial revenue will create a vacuum that may be filled with additional regulated
    revenue, but obviously due to the contractual cap on per passenger fees, that growth would have to
    come from passenger growth and/or more commercial revenue. Passengers have grown about 5% YOY
    the last three months, and I think that’s a decent recovery growth estimate. Another reason regulated
    revenue could grow is if Spanish government bond yields rise, or if Aena de-levers. Aena’s average debt
    maturity is 13 years and is priced on LIBOR.
     
    I think maximum regulated revenue can be modeled pretty reliably using the regulatory formula. Once
    you have the formula, there are two market-based inputs: Spanish bond yields and Spanish CPI. This is
    what I’ve done rather than just targeting revenue per passenger multiplied by passengers. With 5%
    passenger growth, regulated revenue remains at the present level of about €11.40/passenger.
     
    Why iAENA under-earning?
    Probably a combination of a loosely economically motivated owner, and a nonsensical regulatory
    regime. Before 2014, all revenues were counted in determining Aena's regulated returns. This is known
    as a single till system. In other words, EBITDA from duty free shops was added to the numerator used to
    calculate the return on the regulated assets denominator. Starting in 2014, Aena's regulator began the
    process of de-regulating the non-aeronautical activities toward a dual till system. In 2013, 100% of non-
    aeronautical revenues were counted toward the regulated return. In 2014, 80% of non-aeronautical
    revenues counted toward the regulated return. This process will continue in 20% increments until 0% of
    non-aeronautical revenues will count toward the regulated return in 2018. This frees up the ability to
    earn about 20% more commercial revenue each year through 2018, then commercial revenues can be
    as high as the market will bear. These revenues flow through at extremely high incremental margins,
    since the revenue is essentially just rent with little associated operating expenses on Aena’s end.
    Overall EBITDA margins on commercial revenues today are 85%, and go-forward incremental margins
    are likely even higher. Historically, if Aena wanted to earn more commercial revenue, they had to offset
    that growth with lower aeronautical fees, so there was no incentive to develop the commercial
    business.
     
    I don't think Aena is structurally disadvantaged in terms of passenger incomes. Aena's passengers are
    almost all higher-income EU and Spanish citizens.
     
    Weighted average GDP per capita, using passenger mix, and 2014 nominal GDP (not PPP) at 23/3/15
    exchange rates:
     
    Aena    US$28,200
    Paris    US$28,100
    Vienna US$28,900
    Zurich  US$28,200
     
    Commercial revenue per passenger, in USD:
    Aena             4.64
    Developed peers:
    Vienna          6.70
    Frankfurt       8.15
    Copenhagen  10.47
    Auckland      11.68
    Sydney        12.00
    Paris            14.30
    Zurich         15.10
    Emerging peers:
    ASUR          5.65
    Thailand      5.30
    GAP            3.65
    Malaysia     2.00
     
    Aena's commercial revenue per passenger has more in common with its emerging market peers than
    with their European peers. GAP in particular has a high share of local passengers, such as in their largest
    airport in Guadalajara, with potentially much lower average incomes than Aena's passengers. For this
    reason I'm comfortable that commercial revenue per passenger is both unnaturally low and is highly
    unlikely to go much lower. It’s important to note that Vienna operates under a single till regulatory
    regime, so Vienna is not a good comp.
     
    Aeroports de Paris was privatized in 2006. Over the ensuing eight years commercial revenue per
    passenger grew at an 8% CAGR from a starting base twice that of Aena’s, and grew every year through
    an intense, prolonged recession during the majority of this timeframe. ADP is 51% owned by the French
    government, and the CEO receives no bonus and no stock options.
     
    Aeroports de Paris commercial revenues per passenger:
     
     
     
    Aena will tell you that they’re different. Their passengers are poorer, they claim. While their domestic
    passengers probably do have lower average incomes, in aggregate Aena has no basis for this claim.
    They have a higher share of LCC traffic, which statistically has unclear effects on commercial revenue per
    passenger, since LCC passengers aren’t served meals in-flight. They have a lower share of business
    travelers, but business travelers actually have a lower average spend than leisure travelers. It’s not
    surprising to me that Aena doesn’t want to advertise the revenue opportunities they have. As Peter
    Thiel says, monopolists will always lie about the strength of their business to avoid attracting regulatory
    scrutiny and competition, and competitively weak companies will always lie about the weakness of their
    business to attract capital.
     
    Where specifically is Aena under-earning?
     
    Parking
    One of the biggest opportunities in commercial revenue appears to be in parking.
    On parking revenue per domestic passenger, Aena lags very far behind other airport operators:
     
    (All numbers in USD)
    Aena             1.89
    Vienna          3.75
    Sydney         4.33
    Auckland       4.72
    Zurich           9.13
    Frankfurt       12.21
    Paris             12.47
    Copenhagen  23.76
     
    I think this metric might potentially understate the true size of the gap in parking revenue per local
    passenger. Because Aena owns all the airports in Spain, virtually every domestic passenger is local to an
    Aena airport and is likely a potential airport parking customer. Since the other airports only hold
    regional monopolies, not every domestic passenger is local and so not every domestic passenger is a
    potential airport parking customer at those airports.
     
    On revenue per parking space per year, Aena also lags substantially.
    (All numbers in USD)
    Aena              1,014
    Vienna           1,952
    ADP               3,987
    Zurich            4,017
    Auckland        4,343
    Copenhagen   5,187
    Frankfurt       5,633
    Sydney         6,548
     
    Garage parking price for 24 hours, in USD:
    Madrid           22.75
    Barcelona       22.75
    Tijuana          14.00
    Auckland        35.00
    Paris-CDG      42.60
    Copenhagen   44.00
    Vienna           43.50
    Zurich           48.00
    Frankfurt       60.00
    Sydney          71.00
     
    Part of the parking revenue per passenger gap is explained by passenger income. But I think Aena’s
    parking is underpriced relative to passenger income. Below is a scatter plot of GDP per capita in USD at
    current exchange rates against the multiple of GDP per capita to parking prices. The red dot is Aena
    today, with my 2018 base case in purple and 2018 best case in green.
     
     
     
     
    If other airports’ experiences are any guide, at Aena’s passenger income level, they could probably
    charge closer to US$28 for a garage space today versus US$23.
     
    There are also some signs of inefficient price discrimination. Some terminals don’t price discriminate
    between garage and surface lot parking. And the corporate terminal lots charge the same as regular
    terminal lots.
     
    Parking usage is also probably driven by passenger income, among other factors. So I think as the
    Spanish economy recovers, passenger proclivity to use parking may rise. Aena’s parking utilization is the
    same as the Mexican airports. Aena might be able to do things to stimulate demand too, like the recent
    addition of online booking, which I believe is a way to target the more price conscious segment and
    match the capabilities of their off-airport competition. Aena has also been more actively marketing
    their parking. I believe utilization improved by 7% in 2014, just related to the launch of online booking.
     
     
     
     
    The upshot of all this is, if Aena can close the price and usage gaps over 4-5 years, parking revenue per
    domestic passenger could grow at a 10-20% annual rate. In 2018 Aena could be earning US$3-4 per
    domestic passenger versus US$1.90 today.
     
    Retail
    Retail (duty free, other shops, and food & beverage) revenue per passenger, in USD:
    Aena             2.12
    Vienna          2.04
    Frankfurt       3.64
    Paris             3.74
    Copenhagen  4.05
    Zurich           4.36
    Sydney          5.23
    Auckland        6.47
     
    How were retail revenues kept unnaturally low? One likely way is below-market rent. In October 2012
    Aena signed a new agreement with their duty free shop operator, World Duty Free Group, which
    increased Aena's duty free revenue share from 26.9% to 37.4%, and provided for higher guaranteed
    minimum annual rent. Aena left more than 30% of their duty free revenue on the table  this wouldn’t
    be likely in a dual till, profit-motivated company. I was told by the company that the reason Aena
    underpriced this operator’s contract was because WDF is a preferred, local operator, but WDF is an
    Italian company which is majority owned by billionaires. The company also told me that the duty free
    contract renewal was an aggressive process that isn’t likely to be repeated with the other operators, but
    the duty free contract renewal was an open tender process in which seven operators participated, just
    like every other duty free tender in every other airport in the world. And the revenue share is in line
    with other recent duty free tenders. Aena has also been renegotiating the revenue shares on other
    retail and food & beverage outlets.
     
    The increase in guaranteed minimum rent on their duty free shops of €60 million in 2015 versus 2014
    rent is enough in itself to contractually guarantee 7.4total commercial revenue growth for 2015
    without doing anything else. The increased minimum guaranteed rent will cause duty free revenue to
    grow at least 34% in 2015 and at least 15% annualized over the next four years (9% annualized 2016-
    2018 even after the big ramp in 2015).
     
    Because WDF is a public company, and they are the only duty free shop operator in Spain, it’s easy to
    track the underlying performance of the duty free shops. WDF has spoken extensively about the Aena
    contracts publicly because it caused a hit to their EBITDA margins in 2013 and 2014. I believe, based on
    WDF’s public statements, that they were earning margins on the Aena business of about 22% in 2012,
    nearly twice the 12% company-wide average. That’s money that was being charitably donated by the
    Spanish government to Italian billionaires and other WDF shareholders.
     
    WDF has said they expect the Spanish same-store revenues to grow at 7.5% per year through 2017 (3%
    passenger growth and 4.5% average spend). But there’s two interesting things to note here:
    1) they also project their global same-store sales ex-Spain to grow 7.8% annualized in that same time
    period, even though Spanish passenger volume is substantially more depressed than the rest of the
    world. They expect Spanish passengers to grow 3% but project global passengers ex-Spain to grow
    3.4%. WDF’s Spanish duty free same-store sales grew 8.8% in 2014 while Spanish nominal GDP grew
    just .9%, the Euro averaged 20% above today’s level, and the Brent oil price averaged 80% higher than
    today’s levelAena’s February traffic growth was 6.2%, and global traffic grew 6% in 2014.
    2) WDF was given the right to expand Spanish duty free square meters by 33% from 33,000 in 2012 to
    45,000. Square meters grew 18% in 2013, and I think square meters grew 5% in 2014 (subtracting same-
    store sales growth of 9% from total sales growth of 14%). This leaves WDF room to grow square meters
    by an additional 10% in 2015, which appears to be happening, based on their statements that in the first
    two months of 2015 total Spanish sales are up 22.5% and same-store sales are up 6.8%. However, as
    you can see in the chart below, when WDF modeled 2017 Spanish sales, they didn’t include any growth
    in square meters, and I believe the current 2015 run-rate Spanish sales are higher than their 2017
    guidance.
     
     
     
    Source: World Duty Free Group
     
    I think there are at least two incentives for WDF to minimize the opportunity for recovery in Spain. 1)
    WDF has said that they would like to renegotiate the terms of the Aena contracts on the basis that
    Aena’s 2013 traffic forecasts were too optimistic. Aena modeled 5.5% passenger growth for 2013 prior
    to the October 2012 duty free auction process. Actual 2013 traffic declined 12% in Madrid, leaving an
    eight million passenger deficit versus forecast just in Madrid. 2) the WDF CEO lost his job over the Aena
    contract, and the new CEO probably wants to make sure expectations are low.
     
    If WDF’s Spanish sales grow 20% in 2015 and 8% thereafter, I expect that their margins in Spain will
    recover to 16% in 2018, well above company average, and rent could be above the guaranteed
    minimum. The WDF contract runs through the end of October 2020.
     
    Duty free will be over 50% of retail revenue in 2015. Food and beverage will be 27% of retail revenue in
    2015. I just grow food and beverage revenues by 3% per passenger because Aena actually performs well
    in that category, but Aena has noted some initiatives to improve here. The other 20%, convenience
    stores and such, I have less insight into but I have a hard time believing that the duty free rents were the
    only ones underpriced. I grow these other retail revenues at 5% per passenger.
     
    The upshot is, I believe with high conviction that duty free sales per passenger will grow to US$1.50 in
    2018 from US$1.03 in 2014, a 9.5% annual rate. The minimum guaranteed duty free rent will be
    US$1.46 per passenger in 2018, so if the actual varies from my estimate, it wont be more than
    US$.04/passenger lower.
     
     
    Advertising
    I think advertising revenue is probably a pretty straight forward inefficiency to correct. Aena’s
    passengers are essentially the same people as most of the other European airport passengers. I also
    believe that tourist destination ad space is worth more than other airport ad space, because of the large
    potential spend involved, immediacy of decisions, and very targeted audience. I think Aena could easily
    earn .30-.40 per passenger one day, possibly more because of its high mix of tourist traffic. Note that
    Aena is earning 65% less per passenger than single till peer Vienna.
     
    Advertising revenue per passenger (USD):
    Aena    .141
    GAP     .27
    ASUR   .29
    Paris    .338
    OMA     .397
    Vienna  .408
    Zurich   .671
     
    Capex
    Aena's has committed to cutting capex going forward. The company estimates in its prospectus that its
    airports have the capacity to handle 335 million passengers comfortably within the confines of the
    current operating hours, current quality of service levels and current regulatory and environmental
    restrictions. This compares to 2014 traffic of 196 million passengers, giving them room to grow
    passengers 67% before needing to add aggregate new capacity. Management believes Aena has enough
    capacity to accommodate growth through 2025 and beyond.In many airports Aena is operating at 50%
    of capacity.Like the rest of Spain, the airports were overbuilt in the credit boom.
     
     
    Source: Aena
     
    2014 utilization versus theoretical passenger capacity, based on company-supplied public data:
    Aena            59%
    Sydney         65%
    Vienna          75%
    Zurich           79%
    Copenhagen  85%
    Paris             87%
    Frankfurt       88%
     
    For the next 10 years, Aena is limited by regulation to spending no more than €450 million per year in
    capex. Overspending on capex needlessly costs the airlines because it increases the RAB. So whatever
    you think true maintenance capex is, €450 million is the worst case by law.
     
    Here's how Aena breaks out their capex spend over the last three years:
                                   2014  2013  2012
    Capacity Expansion   72      149     381
    Expropriation            78      91      76
    Other                       21      59      125
    Total Growth Capex   171    299    582
    Security                    33     79      125
    Environment             12     18       22
    Service Maintenance  84     72       66
    Total Maintenance     129   169      213
     
    Security and Environment are maintenance costs since security technology will always need to be
    improved and not just maintained. Environmental capex mainly relates to sound insulation costs for
    nearby homes. Expropriation is money that's spent to buy the land necessary to add runways and
    terminals. I'm including Other in growth because it includes mostly capex to expand and improve
    commercial square footage and it generates a good incremental return.
     
    The average annual maintenance capex over the last three years has been 170 million. I'm using €200
    million going forward.
     
    Sydney management says that their maintenance capex is A$15 million per year because of their
    advantageous utilization position. If Aena spent at the same percentage of gross PP&E, their
    maintenance capex would be €88 million. Sydney’s estimate seems aggressive to me, but management
    is confident enough in it to pay out 100% of EBITDA - Interest - Taxes - Maintenance Capex. This is one
    reason I believe Sydney gets the premier valuation in the sector, and I believe Aena could be similarly
    situated if they demonstrated Aena’s earnings power with an aggressive dividend payout policy.
    Sydney’s equity trades for 25x this measure of no-growth FCF, and is growing passengers and
    commercial revenue per passenger more slowly than Aena is growing. Aena is likely the best-situated
    airport in the developed world in terms of capital needs per incremental passenger for the next 10+
    years.
     
    What are the political risks?
    Podemos, a radical left party is polling well  probably in a dead heat with the governing conservative
    party  for the general election on 20 December 2015, in which almost all seats in the legislature are up
    for re-election. Privatizations are unpopular with left-leaning politicians. So it's important to spend a lot
    of time thinking about this risk, though I’m a very unqualified Spanish political analyst.
     
    I don't expect that raising commercial revenues will be politically unpopular. For one, airport
    passengers are mostly higher income. For two, these are discretionary purchases for these higher
    income passengersAena has agreed to freeze non-discretionary fees for 10 years. For three, the
    revenue that we're talking about will actually be coming from concession operators who were
    previously being subsidized. I don't think that Podemos cares about either constituency. They perhaps
    do care about the tax revenue and dividends that the government will get from Aena. I also think that
    the Spanish and European courts may provide a reasonably reliable source of property rights protection.
    Spain and the EU are real governments with legitimate court systems, and they aren’t Venezuela.
     
    One Podemos legislator mentioned that he wanted to re-nationalize Aena, though he subsequently de-
    escalated his rhetoric to just say that Spain should never sell more than 49%. Other than that, the news
    about Aena has been a trickle at most since after the IPO.
     
    I think the biggest risk is if the legislature reverses the switch to a dual till system, but I see virtually no
    incentive to do so. Podemos won’t win a majority in the legislature (they’re polling at 22.5%), so they
    wonhave free rein to create a socialist utopia. An aggressive regulator could play with some of the
    variables used to calculate Aena’s regulated income, though I think these kinds of changes would have a
    relatively small effect.
     
    I would also note that the French government owns 51% of Aeroports de Paris, and ADP has the highest
    commercial revenue per passenger of all the publicly traded comps and are guiding to phenomenal
    growth of 18% in 2015 to €19/passenger. That has caused no controversy.
     
    In some ways a Podemos victory could be positive for Aena. If Spanish yields rise as Greek yields did
    after Syriza’s victory, it will increase Aena’s regulatory cost of capital without increasing its actual cost of
    capital. Podemos has spoken openly about wanting to restructure the national debt. Also if Podemos
    engages in fiscal stimulus, it will be positive for Spanish GDP.
     
    Land Holdings
    Aena owns 4,940 acres (2,000 hectares) of land adjacent to its airports that it describes in its prospectus
    as “largely underdeveloped. 80% of this land is in Madrid and Barcelona, according to former
    management. Former management believes there is a lot of pent up demand for airport hotels in
    Madrid and Barcelona.
     
    Auckland International owns 3,707 acres adjacent to its airport that it values at US$2.65 billion, or
    US$536,000 per acre at 30/9/14. At the same value per acre, Aena’s land could be worth €2.3 billion.
     
    Airports de Paris owns 3,200 acres (1,310 hectares) of excess land that they have been aggressively
    leasing out. Their appraisers have valued it at €2.1 billion at 12/31/14, €650,000 per acre. At the same
    valuation per acre, Aena’s land could be worth €3.2 billion. ADP has leased out about 70% of their land,
    probably